Economic Calculation Problem

Introduction

An argument about the impossibility of economic planning has been going around since the 1920’s called the Calculation Problem.

Wikipedia says,

"The economic calculation problem is a criticism of using economic planning as a substitute for market-based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article "Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek. In his first article, Mises describes the nature of the price system under capitalism and describes how individual subjective values are translated into the objective information necessary for rational allocation of resources in society."

Description

From the Wikipedia:

"The economic calculation problem is a criticism of using economic planning as a substitute for market-based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article "Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek.[1][2] In his first article, Mises describes the nature of the price system under capitalism and describes how individual subjective values are translated into the objective information necessary for rational allocation of resources in society.[citation needed]

In market exchanges, prices reflect the supply and demand of resources, labor and products. In his first article, Mises focused his criticism on the inevitable deficiencies of the socialisation of capital goods, but Mises later went on to elaborate on various different forms of socialism in his book, Socialism. Mises and Hayek argued that economic calculation is only possible by information provided through market prices, and that bureaucratic or technocratic methods of allocation lack methods to rationally allocate resources. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by economic historians as The Socialist Calculation Debate. Mises' initial criticism received multiple reactions and led to the conception of trial-and-error market socialism, most notably the Lange–Lerner theorem.

Mises argued in "Economic Calculation in the Socialist Commonwealth" that the pricing systems in socialist economies were necessarily deficient because if a public entity owned all the means of production, no rational prices could be obtained for capital goods as they were merely internal transfers of goods and not "objects of exchange," unlike final goods. Therefore, they were unpriced and hence the system would be necessarily irrational, as the central planners would not know how to allocate the available resources efficiently.[1] He wrote "...that rational economic activity is impossible in a socialist commonwealth."[1] Mises developed his critique of socialism more completely in his 1922 book Socialism, an Economic and Sociological Analysis, arguing that the market price system is an expression of praxeology and can not be replicated by any form of bureaucracy.

However, it is important to note that central planning has been criticized by socialists who advocated decentralized mechanisms of economic coordination, including mutualist Pierre-Joseph Proudhon, marxist Leon Trotsky and anarcho- communist Peter Kropotkin before the Austrian school critique. Central planning was later criticized by socialist economists such as Janos Kornai and Alec Nove. In particular, Trotsky argued that central planners would not be able to respond effectively to local changes in the economy because they operate without meaningful input and participation by the millions of economic actors in the economy, and would therefore be an ineffective mechanism for coordinating economic activity." (http://en.wikipedia.org/wiki/Economic_calculation_problem)

Discussion

Jean-Daniel Cusin:

"Cosma Shalizi is good at the math behind optimization software, among other things. In the excerpts and linked article below, he agrees that an optimally planned economy is impossible, but says that so is an optimally market-driven invisible-hand capitalist economy guided by prices. In other words, the claims of Mises and Hayek that “the market” can rationally allocate resources don’t hold water either. (As we have seen in the latest crash and bailout of finance capital.)

Yet and still, I think that a non-capitalist, democratically planned, and peer-to-peer coordinated economy is possible and necessary. It just won’t be optimal. But do you think the current economy is?

More below, after some excerpts from Shalizi.

In that, part of a seminar about the book Red Plenty (which described an attempt to optimize economic planning in the Soviet Union), Shalizi writes:

"Planning for the whole economy would, under the most favorable possible assumptions, be intractable for the foreseeable future, and deciding on a plan runs into difficulties we have no idea how to solve. The sort of efficient planned economy dreamed of by the characters in Red Plenty is something we have no clue of how to bring about, even if we were willing to accept dictatorship to do so."

But also:

"Both neo-classical and Austrian economists make a fetish (in several senses) of markets and market prices. That this is crazy is reflected in the fact that even under capitalism, immense areas of the economy are not coordinated through the market...This is not just because the market revolution has not been pushed far enough. ("One effort more, shareholders, if you would be libertarians!") The conditions under which equilibrium prices really are all a decision-maker needs to know, and really are sufficient for coordination, are so extreme as to be absurd. (Stiglitz is good on some of the failure modes.) Even if they hold, the market only lets people "serve notice of their needs and of their relative strength" up to a limit set by how much money they have. This is why careful economists talk about balancing supply and "effective" demand, demand backed by money."

This is just as much an implicit choice of values as handing the planners an objective function and letting them fire up their optimization algorithm. Those values are not pretty. They are that the whims of the rich matter more than the needs of the poor; that it is more important to keep bond traders in strippers and cocaine than feed hungry children. At the extreme, the market literally starves people to death, because feeding them is a less "efficient" use of food than helping rich people eat more.

Moreover:

"If it's any consolation, allowing non-convexity messes up the markets-are-always-optimal theorems of neo-classical/bourgeois economics, too. (This illustrates Stiglitz's contention that if the neo-classicals were right about how capitalism works, Kantorovich-style socialism would have been perfectly viable.) Markets with non-convex production [added note: that is, all real-world markets] are apt to see things like monopolies, or at least monopolistic competition, path dependence, and, actual profits and power. (My university owes its existence to Mr. Carnegie's luck, skill, and ruthlessness in exploiting the non-convexities of making steel.) Somehow, I do not think that this will be much consolation."

Shalizi is much better at thinking about optimization than I am. He has the math and the experience. I have neither. So I will accept his conclusion that optimizing a whole economy is impossible, and plunge ahead regardless."

Why the Economic Calculation Problem Prevents a Direct Transformation Towards a Marketless and Stateless Society

by Seth Ackerman:

"The lofty vision of a stateless, marketless world faces obstacles that are not moral but technical, and it’s important to grasp exactly what they are.

We have to assume that we would not want to regress to some sharply lower stage of economic development in the future; we would want to experience at least the same material comforts that we have under capitalism. On a qualitative level, of course, all sorts of things ought to change so that production better satisfies real human and ecological needs. But we would not want to see an overall decline in our productive powers.

But the kind of production of which we are now capable requires a vast and complex division of labor. This presents a tricky problem. To get a concrete sense of what it means, think of the way Americans lived at the time of the American Revolution, when the typical citizen worked on a small, relatively isolated family farm. Such households largely produced what they consumed and consumed what they produced. If they found themselves with a modest surplus of farm produce, they might sell it to others nearby, and with the money they earned they could buy a few luxuries. For the most part, though, they did not rely on other people to provide them with the things they needed to live.

Compare that situation with our own. Not only do we rely on others for our goods, but the sheer number of people we rely on has increased to staggering proportions.

Look around the room you’re sitting in and think of your possessions. Now try to think of how many people were directly involved in their production. The laptop I’m typing on, for example, has a monitor, a case, a DVD player, and a microprocessor. Each was likely made in a separate factory, possibly in different countries, by various companies employing hundreds or thousands of workers. Then think of the raw plastic, metal, and rubber that went into those component parts, and all the people involved in producing them. Add the makers of the fuel that fired the factories and the ship crews and trucking fleets that got the computer to its destination. It’s not hard to imagine millions of people participating in the production of just those items now sitting on my desk. And out of the millions of tasks involved, each individual performed only a tiny set of discrete steps.

How did they each know what to do? Of course, most of these people were employees, and their bosses told them what to do. But how did their bosses know how much plastic to produce? And how did they know to send the weaker, softer kind of plastic to the computer company, even though it would have been happy to take the sturdier, high-quality plastic reserved for the hospital equipment makers? And how did these manufacturers judge whether it was worth the extra resources to make laptops with nice LCD monitors, rather than being frugal and making old, simpler cathode ray models?

The total number of such dilemmas is practically infinite for a modern economy with millions of different products and billions of workers and consumers. And they must all be resolved in a way that is globally consistent, because at any given moment there are only so many workers and machines to go around, so making more of one thing means making less of another. Resources can be combined in an almost infinite number of possible permutations; some might satisfy society’s material needs and desires fairly well, while others would be disastrous, involving huge quantities of unwanted production and lots of desirable things going unmade. In theory, any degree of success is possible.

This is the problem of economic calculation. In a market economy, prices perform this function. And the reason prices can work is that they convey systematic information concerning how much of one thing people are willing to give up to get another thing, under a given set of circumstances. Only by requiring people to give up one thing to get another, in some ratio, can quantitative information be generated about how much, in relative terms, people value those things. And only by knowing how much relative value people place on millions of different things can producers embedded in this vast network make rational decisions about what their minute contribution to the overall system ought to be.

None of this means that calculation can be accomplished through prices alone, or that the prices generated in a market are somehow ideal or optimal. But there is no way a decentralized system could continually generate and broadcast so much quantitative information without the use of prices in some form. Of course, we don’t have to have a decentralized system. We could have a centrally planned economy, in which all or most of society’s production decisions are delegated to professional planners with computers. Their task would be extremely complex and their performance uncertain. But at least such a system would provide some method for economic calculation: the planners would try to gather all the necessary information into their central department and then figure out what everyone needs to do.

So something needs to perform the economic calculation function that prices do for a market system and planners do for a centrally planned system." (https://www.jacobinmag.com/2012/12/the-red-and-the-black/)

Discussion 2: Proposed Alternatives

The Parecon Proposals

Seth Ackerman finds them wanting:

"As it happens, an attempt has been made to spell out exactly what would be required for economic calculation in a world with no states or markets. The anarchist activist Michael Albert and the economist Robin Hahnel have devised a system they call Participatory Economics in which every individual’s freely made decisions about production and consumption would be coordinated by means of a vast society-wide plan formulated through a “participatory” process with no central bureaucracy.

Parecon, as it’s called, is an interesting exercise for our purposes, because it rigorously works out exactly what would be needed to run such an “anarchist” economy. And the answer is roughly as follows: At the beginning of each year, everyone must write out a list of every item he or she plans to consume over the course of the year, along with the quantity of each item. In writing these lists, everyone consults a tentative list of prices for every product in the economy (keep in mind there are more than two million products in Amazon.com’s “kitchen and dining” category alone), and the total value of a person’s requests may not exceed his or her personal “budget,” which is determined by how much he or she promises to work that year.

Since the initial prices are only tentative estimates, a network of direct-democratic councils must feed everyone’s consumption lists and work pledges into computers, in order to generate an improved set of prices that will bring planned levels of production and consumption (supply and demand) closer to balance. This improved price list is then published, which kicks off a second “iteration” of the process: now everyone has to rewrite their consumption requests and work pledges all over again, according to the new prices. The whole procedure is repeated several times until supply and demand are finally balanced. Eventually, everyone votes to choose between several possible plans.

In their speaking and writing, Albert and Hahnel narrate this remarkable process to show how attractive and feasible their system would be. But for many people — I would include myself in this group — the effect is exactly the opposite. It comes off instead as a precise demonstration of why economic calculation in the absence of markets or state planning would be, if perhaps not impossible in theory, at least impossible to imagine working in a way that most people could live with in practice. And Parecon is itself a compromise from the purist’s point of view, since it violates the principle “from each according to ability, to each according to need” — individuals’ consumption requests are not allowed to exceed their work pledges. But of course without that stipulation, the plans wouldn’t add up at all." ((https://www.jacobinmag.com/2012/12/the-red-and-the-black/))

==P2P Proposals for a Mutual Coordination economy through Stigmergy

For more details, see our special section on Mutual Coordination Economics.

Michel Bauwens:

"0. What market pricing is to capitalism and planning is to state-based production, mutual coordination is to commons-based peer production!

1. Today we have the emergence of a new proto-system of production, Commons-Based Peer Production in which contributors are free to contribute to a common pool of shareable knowledge, code and design, which may be associated through physical production in microfactories using distributed machinery such as 3D printing.

2. This emerging new system of value creation and distribution is not sustainable if contributors need to find work as labour for capital, so contributors need to be able to generate livelihoods for themselves, keeping the generation of surplus value within the sphere of the commons and its contributors.

3. To achieve this, we advocate the use of Commons-Based Reciprocity Licenses such as the Peer Production License. This allows for the creation of a non-capitalist 'counter' economy based on Open Cooperativism and other forms of an ethical economy. In this proposal, the commoners or peer producers, i.e. the contributors to the commons, are also cooperators of their own corporate entities, which create livelihoods and insure the surplus value remains within the commons. So, in between the sphere of the accumulation of the commons (open input, participatory process, commons-oriented output), and the sphere of capital accumulation, there is a intermediary sphere of cooperative production, which regulates physical production and the social reproduction of the commoners-cooperators.

4. The production of immaterial common pools is already regulated through mutual coordination and stigmergy, i.e. coordination based on open and transparent signals of what is needed by the system; but physical production cannot be coordinated without similar signals, i.e. the coordination of production through information. It is therefore a next logical step to advocate and practice, within the ethical entrepreneurial coalitions that coalesce around particular commons through their shared adherence to the commons-based licenses, to also practice open accounting and open supply-chains and logistics. This means that within these coalitions, physical production can also be coordinated through stigmergic signals; and negotiated coordination and even voluntary common planning can take place on the basis of the shared production information."